Understanding your down payment and PMI.
Saving for a down payment can be daunting, especially in today’s unpredictable market. While prices vary widely throughout the country, the average price of a home in the U.S. as of May 2023 is around $339,000. That means you would have to save $67,800 to make a 20% down payment. But what if your down payment is lower than 20%? That's where private mortgage insurance comes in.
Private mortgage insurance enables you to secure a conventional mortgage with less than 20% down. A lower down payment, however, means you move in with less equity in the property. Because of that, conventional mortgage lenders will require that you purchase PMI as part of your mortgage. PMI exists to protect the lender in the event that the homeowner stops making their mortgage payments.
Typically, PMI is added as part of your regular monthly mortgage payment. While PMI is charged on conventional mortgages, all mortgages with a down payment of less than 20% require some form of mortgage insurance. Here are some examples of different types of mortgage insurances:
- Conventional loans charge PMIs. These loans include fixed-rate and adjustable-rate mortgages.
- Government-backed loans charge MIPs. These loans include FHA and USDA mortgages. Both of these charge monthly Mortgage Insurance Premium (MIP) payments that work very similar to PMIs, plus a one-time fee. FHA loans are backed by the Federal Housing Authority, and their one-time fee (UPMIP) is 1.75% of the loan paid up front during closing. USDA loans are backed by the U.S. Department of Agriculture for property in rural and less populated suburban areas. Instead USDA loans have has a one-time, up-front guarantee fee and an annual fee financed throughout the life of the loan.
- VA loans charge a one-time funding fee. These loans are backed by the U.S. Department of Veterans Affairs and their funding fees are also financed throughout the duration of the loan.
How much does private mortgage insurance cost?
Actual PMI amounts will vary depending on your mortgage amount, the type of mortgage secured, down payment amount, and your credit score.
According to Investopedia, the average PMI annually costs between 0.5 to 2.25% of the mortgage amount. For example, here’s the calculations for a $270,000 mortgage and annual PMI costs 1% of the mortgage cost:
$270,000 mortgage x .01 = $2,700 annual PMI ÷ 12 months = $225 monthly PMI
How long do you have to pay private mortgage insurance?
With a conventional mortgage, you can submit a request in writing to remove PMI from your payments once you own 20% equity in your home. This is also called having a loan-to-value (LTV) ratio of less than 80%. This means your remaining loan amount is less than 80% of the home’s assessed value. If you can pay additional principal each month, you’ll reach 20% equity sooner!
Some lenders might also require a formal re-appraisal of the home before canceling your PMI. Additionally, you could be obligated to continue paying PMI for a pre-designated time period, so understand the terms before you sign.
MIPs and VA funding fees are paid for the life of the loan, but some buyers are able to refinance these loans as conventional loans to eliminate mortgage insurance charges.
Make your best move
Is it better to pay PMI to buy a home sooner or to continue paying rent while you save a 20% down payment? Whatever you decide, we’re here to help with both great savings options and a variety of mortgages, too.
Once you’re ready to make the move, one of our Mortgage Loan Officers can help bring your homebuying dreams into reality.